Is there such a thing as too much capital?

Posted on 3/15/2019

It’s not unusual for a borrower to submit a loan proposal to a bank or a community lender like CEDF for more money than the numbers will support. It’s our obligation to make sure that the ratio called global debt service is in line with reality. This means considering all of the financial obligations of the borrower personally, as well as the capabilities of the business, can the loan be repaid at the contemplated terms? We won’t offer the loan if this condition can’t be met.

That’s also why typical loan covenants forbid a borrower taking on more outside debt without a lender’s approval. It can rock the boat and make the ship roll over.

Sometimes, if only a lesser loan amount can be supported, the loan officer will ask the applicant if the business plan can be realistically changed and still work. This is entirely a business judgement of the applicant. The lender wants to accommodate by approving a modified proposal, but a lender can’t promise that a smaller loan is workable.

Sadly, the enthusiasm and determination of borrowers sometimes outweighs their judgement. It’s frustrating when a CEDF business advisor, trying to help a distressed client some months down the line, hears the peril that the client is facing was caused, “because you didn’t give me enough money.” The unwelcome truth is that had the client been allowed to borrow more, odds are the bottom might have dropped out even sooner.

Another fantasy of inexperienced small business owners is the idea that getting free of debt and raising big money in the equity markets is somehow a dream come true. Appropriate debt financing is cheaper than equity financing. There’s no shame in using it.